One of the most talked about investment themes of 2013 has been the dramatic turnaround in the Japanese economy as a result of Abenomics. While equities and the value of the yen have dominated headlines, one area investors might not be as familiar with is the Japanese government bond (JGB) market. When talking about bond investing, we believe it is important to maintain perspective on what debt investing really represents. When an investor purchases a bond, it is the same thing as lending money to a borrower. As we will discuss, the Japanese bond market is currently one of the most interesting markets in finance.
As one of the largest developed market economies in the world, the JGB market is truly massive. In fact, according to the Japanese Ministry of Finance, the total value of the Japanese government bond market stood at ¥1.01 quadrillion ($10.3 trillion) as of September 30, 2013—its highest level ever.1 Given the market’s size, it is also regarded as one of the most liquid bond markets in the world. According to Barclays, Japanese government debt accounts for nearly 29% of the Barclays Global Treasury Index, representing its largest individual country weight.2 However, particularly large debt markets can sometimes be a double-edged sword for investors. In our view, just because a country has a large amount of debt outstanding doesn’t necessarily mean it deserves a significant portion of an investor’s portfolio.
As bond investors, we care principally about lending money at rates that adequately compensate us for the risks we are taking. One of the most confusing elements for foreign investors looking at the Japanese bond market is that it is not only the largest government bond market in the world but also home to the lowest government borrowing costs. Generally speaking, investors have traditionally used yields as a generic barometer of creditworthiness or risk. By this metric, it appears that Japan is one of the most worthy creditors in the world, with 10-year government bond yields of 0.60%.3 Interestingly, despite its large presence in the Barclays Global Treasury Index, it contributes only 16 basis points to the overall index yield of 1.47% (11% of the index yield compared to nearly 30% of the weight). For this reason, Japanese debt has generally not been a favored allocation for international investors.